Barclays Sees December Taper, Bond Yields Moving Higher

By Michael Aneiro

Everybody continues to weigh in on when they now think the Fed is going to start tapering its , given the wrench that the government shutdown and debt-ceiling standoff threw into previous expectations. Barclays‘ fixed-income strategist Ajay Rajadhyaksha comes in on the early end of expectations when he says the Fed is still most likely to start tapering in December. Here’s Rajadhyaksha:

The economic effect of the shutdown should be limited. Our economists have estimated the cumulative hit at 25bp of GDP growth (annualized) in Q4, with much of this likely to be recovered in Q1 14. In our view, this should not be a huge driver of Fed policy decisions. Nevertheless, we have heard investors express the view that the Fed is now almost certain not to taper in December. Their argument goes that even if the Fed looks past lost growth, it will worry about the prospect of a new political negotiation in January-February.

Yet, we think that if the debt ceiling fight is unlikely to repeat (and, even if it does recur, it will not be until mid year) and the effect of a shutdown is limited, why should the Fed be driven more by politics than by data? Moreover, the Fed will not be operating in a vacuum: although some data collection has been missed during the shutdown, the most important indicators, such as the labor market report for October, will be available. Hence, we think the Fed’s data-dependence will persist and that December remains the most likely timing for tapering, given our forecast that job creation will be stronger in Q4 than in Q3.

Barclays points out that credit spreads have tightened over the past two weeks and bond yields have remained within a narrow range, but trading volume has dropped sharply. Barclays chalks that up to three factors: uncertainty about the debt ceiling and shutdown; the lack of incoming economic data during the shutdown; and investors wanting to hear from the Fed, particularly from presumptive Fed Chair Janet Yellen, who hasn’t made a public statement in several months. More from Barclays:

All three factors should now fade. The debt limit has been raised, and the government is open. A rush of economic data – including two months of payroll reports in a span of two weeks is in the pipeline, and Ms Yellen’s confirmation hearing will provide more detail into her thinking. The result is likely to be a surge in trading activity in the next few weeks, and we believe the bias will be for higher yields.